Why Crude Inventories Surged This Week

While U.S. crude oil inventories have been surging since last fall, I have argued that these inventories should peak off soon. There are several reasons for this, but the primary reason is that March is historically the month that refinery utilization is at its lowest, due to the popularity of performing refinery maintenance during the month. The difference in crude oil demand from refiners between March and July has historically been about 10 million barrels per week. This alone should be enough to halt the ~8 million weekly crude oil build that we have seen thus far in 2015.

Another factor is that the large capital spending cuts that have accompanied the oil price collapse will begin to negatively impact oil production. The Energy Information Administration reported 2 weeks ago that U.S. oil production had suffered a weekly decline for the first time since January. Last week, production was almost flat, up only 18,000 bpd over the previous week. Meanwhile, U.S. refinery inputs surged by 201,000 bpd, climbing back above 90% utilization for the first time in 2 months. This should have dropped crude oil inventories by more than a million barrels for the week, but the EIA reported a huge inventory build of nearly 11 million barrels for the week.

What is the explanation for this?

The biggest factor seems to be a surge of crude oil imports of 869,000 bpd, or 6.1 million barrels for the week. This isn’t an anomaly either. Over the past year as U.S. crude oil production rose by 1.2 million bpd, U.S. crude oil imports also rose by 900,000 bpd. Refinery inputs, on the other hand, only increased by 592,000 bpd year-over-year.

The production, refinery consumption, import, and storage numbers still leave about 5 million barrels unaccounted for the week. There is of course some margin of error in the measurements, but that’s a pretty significant number. I have inquired with the EIA about the apparent discrepancy.

However, at the important storage hub of Cushing, Oklahoma the inventory build was only 1.3 million barrels, about half of the average weekly gain over the past month. And across PADD 2 — the Midwest region that includes Cushing — crude oil inventories actually fell slightly from the previous week.

Despite the continued build in inventories, it seems that analysts and traders are beginning to conclude what I have argued here: Inventories are not going to fill completely up, forcing producers to slash production. As a result (and despite the tentative nuclear deal with Iran), the price of West Texas Intermediate (WTI) reached a 2015 high of $54/bbl this week before pulling back 4% following the release of the latest inventory report.

Certainly something has to give soon, but that something may very well be crude oil imports. Refinery inputs are now rising faster than U.S. oil production, so the only major source adding to crude oil inventories is rising crude oil imports.

Interesting post Robert and I appreciate you keeping us up-to-date on the inventory situation as it is something that I have been following closely. The stubbornly high level of imports in the first quarter of 2015 has puzzled me as well. The potential factors that I can think of boil down to:

1) Increasing volumes being purchased and stored by speculators taking
advantage of contango have required refiners to rely more on imports than
they would have to otherwise (have not found any specific data to support
this claim)
2) Import agreements between refiners and exporters have limited the ability of refiners to reduce imports, e.g. Citgo locked into volumes from Venezuela
(YTD 2015 imports from Canada has risen by ~500 MBPD while imports
from Venezuela / Mexico have only fallen by ~150 MBPD)
3) Grade specific imbalances and the inability of refiners to reduce light sweet
imports further (PADD3 light sweet or sour imports were down to <60
MBPD in 2014)

There has been significant coverage of the third factor but limited discussion on the first two. Any thoughts on which of these factors might be driving the high import levels or is there potentially some other reason out there?

I think you are correct, that there is a fair amount of the first factor going on. It is still pretty lucrative to store the oil as long as there is still space and the storage costs aren’t prohibitive. The market is still in contango, although the differential has shrunk over the past month.

You are correct that it is a low/medium reward investment but it actually carries minimal risk. If a speculator has access to Cushing crude storage at ~$1/barrel/month and the contango is steep enough that WTI futures 6 months out are trading at more than $6/barrel higher than spot WTI prices, the speculator can immediately sell the futures contracts, use the proceeds to buy the physical barrels at spot prices and pay for the storage out of the remaining margin. Since they already locked in the arbitrage by selling the futures, they are no longer exposed to commodity price risk.

The biggest barrier limiting the ability to take advantage of the contango arbitrage is access to affordable storage. Unless traders/speculators have remaining availability under fixed contracts, prices on storage will likely rise as overall storage levels increase. A lack of visibility into overall storage price levels and the actual users of crude storage makes it difficult to estimate how much speculators are potentially causing increased demand for imports.

When a futures contract is sold, the seller does not receive any proceeds. He has to put up a performance bond (margin) that is marked-to-market (in real time, every day). So, in the storage arbitrage example, a speculator would have to come up with financing to buy the physical oil which he would later deliver against his short futures contract.

The local investing news show had warning of the presidents Iran nuclear agreement and lifting of sanctions for bait. Something that would hurt U.S. oil business, as we would be on the hook to import Iranian crude oil. This guy thought the move would be significant and damaging.